Perfect Competition

CH 9

Hans Martinez

Western University

Perfect Competition (Review)

  • What is Perfect Competition?
  • Profit Maximization by a Price-Taking Firm
  • Short-Run vs. Long-Run Equilibrium
  • Economic Rent and Producer Surplus
  • Profit Maximization Implies Cost Minimization

Perfectly Competitive Markets

  • A perfectly competitive market consists of firms that produce identical products that sell at the same price

  • Each firm’s volume of output is so small in comparison to the overall market demand that no single firm has an impact on the market price

Perfectly Competitive Markets - Conditions

  1. The industry is fragmented
    • It consists of many buyers and sellers
  2. Firms produce undifferentiated products
    • Consumers perceive the products to be identical no matter who produces them
  3. Consumers have perfect information about prices
    • The industry is characterized by equal access to resources
  4. All firms —incumbents and prospective entrants— have access to the same technology and inputs

Implications of Conditions

  • The first characteristic implies that sellers and buyers act as price takers

  • The second and third characteristics imply a law of one price

  • The fourth characteristic implies that the industry is characterized by free entry

The Profit Maximization Hypothesis

\[ \begin{align} \max_{Q} \pi(Q)&=R(Q)-C(Q) \\ \text{s.t. } Q&\ge0 \end{align} \qquad(1)\]

  • Economic Profit = Sales Revenue - Economic (Opportunity) Cost

  • firm sells output Q; R(Q), revenue from selling the quantity; C(Q) = economic cost of producing the quantity Q

The Profit Maximization Condition Continued